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FRM Part II · FRM Exam Part II · Central Clearing

A CCP's default waterfall has the following order of loss absorption after a clearing member defaults. Which sequence is the standard ordering?

The defaulter's own margin and default fund contribution are used first, then the CCP's own capital (skin in the game), then the surviving members' default fund contributions. This ordering ensures the defaulter pays first and gives the CCP an incentive to manage risk prudently.

  1. ADefaulter's initial margin and default fund contribution, then CCP's own capital contribution (skin in the game), then surviving members' default fund contributionsCorrect
  2. BSurviving members' default fund contributions, then defaulter's initial margin, then CCP skin in the game
  3. CCCP skin in the game, then surviving members' default fund contributions, then defaulter's initial margin
  4. DSurviving members' default fund contributions, then CCP skin in the game, then defaulter's margin

Explanation

The defaulter pays first: its variation and initial margin and its default fund contribution. Then the CCP's dedicated own resources are used, and only then are mutualised contributions of survivors drawn. Options placing survivors before the defaulter's own resources reverse the defaulter-pays principle.

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